NEW YORK — The Federal Reserve's annual economic policy symposium in Jackson Hole, Wyoming, held from the 27th to the 29th, was packed with reporters from the United States, South Korea and Japan from the opening session. The coverage ran hot for all three days, enough to make last year's event — the final one led by former Fed Chair Jerome Powell — look thin by comparison. What was the market so curious about from Fed Chair Kevin Warsh, a man who had kept his mouth so firmly shut that he scrapped forward guidance, the practice of signaling the direction of monetary policy in advance, for the first time in 15 years?
The Fed has a famous maxim: the central bank's job is to take away the punch bowl just as the party gets going. The line came from former Chairman William Martin, the longest-serving Fed chief from 1951 to 1970, who delivered it in 1955 when the U.S. economy was enjoying an unprecedented postwar boom. Market participants knew well that the inflation party had to end about here, looking at a Middle East war with no exit, worsening crude supply problems, swelling debt in major economies, artificial intelligence infrastructure investment piling debt on debt, a weaponized tariff war and U.S. economic growth standing alone in its strength. Sovereign bond yields, which had climbed to their highest levels since the global financial crisis, reflected a world economy already staggering from drink. The question worldwide was whether Warsh would keep silent even under these conditions, mindful of President Donald Trump's demands for monetary easing.
Warsh chose to make his resolve on inflation unmistakably clear. His Jackson Hole keynote, which had been expected to be as terse as a Federal Open Market Committee statement or news conference, ran more than 3,500 words and lasted 30 minutes. Senior central bank officials from various countries who had known Warsh before he took office were heard murmuring afterward that he had clearly been a hawk, a policymaker favoring tighter money, all along and had finally dropped the disguise. Some said Warsh was taking care not to follow the path of former Fed Chairman Arthur Burns. Burns bowed to former President Richard Nixon's demands for rate cuts as Nixon sought reelection, triggering the worst stagflation, a combination of high inflation and recession. He was the first academic to lead the Fed, having served as president of the American Economic Association, but lost even his scholarly reputation after his tenure there.
At Jackson Hole there were also cautious guesses that Warsh might raise rates using resistance from hawkish members as cover. What followed unfolded with surprising fidelity to that script. Warsh in fact deflected pressure by calling Trump just before the rate increase, asking for his understanding on the grounds that the mood on the committee left him no choice.
Wall Street is now preparing for the possibility that this rate increase marks the opening shot of a new tightening cycle aimed at calming long-run inflation. Fed officials put their rate projections for the end of this year and next year at an identical 4.1% in the dot plot, but few experts are confident of a string of holds in the new year. There are simply too many uncertainties that could shake prices. In the Fed's history, the only real instance of a one-off rate increase came in March 1997, just before the East Asian financial crisis.
The signal of further U.S. rate increases has deepened South Korea's dilemma. Considering only the exchange rate and capital outflows, which are tied directly to confidence in the national economy, the Monetary Policy Board here would have to weigh defensive additional tightening. On the other hand, with household debt past 2,000 trillion won, mortgage rates above 7% and rising interest burdens on small and mid-sized companies, rates cannot be raised too steeply either. South Korea has also yet to reach agreement with the United States on its first U.S. investment project. Bank of Korea Governor Shin Hyun-song, whom this reporter met at Jackson Hole, said that South Korea does not necessarily have to raise rates just because the United States does, while stressing that the biggest factor moving the exchange rate is the rate gap between the two countries.
The scenario of greatest concern is one in which fiscal expansion driven by political considerations falls out of step with monetary policy. South Korea has already set next year's budget at 821 trillion won, up 12.8% from this year. If that includes a large share of cash handouts, it could amount to the government showing up with a jug of makgeolli at a party where the central bank has already removed the punch bowl. South Korea should also remember that the issue that decisively pushed down U.S. Treasury prices just before the Fed's rate increase was Trump's pledge to hand out $5,000 dividends to every citizen.
